Japan's style of innovation failed it in software and biotechnology in the 1990s. It might work better in robotics, aerospace and other burgeoning technologies

IF JAPAN really is back, as its vaulting stockmarket suggests, then in which global businesses will its companies excel? Growing numbers of investors and onlookers have been asking this since the summer, as evidence has mounted that an economic recovery really is under way (see article). It is both a refreshing question and an important one. Refreshing because, for most of the past 15 years, the chief inquiry about Japan has been when it would finally exit from its debt-driven deflationary funk; important because, now that Japan is finally returning to health, investors and foreign rivals want to know whether its firms will regain some of their once fearsome competitiveness.

The tempting answer is that those foreign rivals can breathe easy. The end of deflation in Japan, which now seems imminent, will be much better for the country's domestic economy than for its exporters and multinational companies. Inflation will lead to higher sales at home, and lift the price of domestic assets such as property and shares; but it will not give a dramatic boost to firms competing overseas.

To thrive away from home, Japanese companies will instead have to innovate. On the face of it, they look capable of meeting that challenge. After all, they have pioneered and perfected many of the most advanced manufacturing and industrial technologies. Some of their futuristic visions were on display this summer, at the world expo that Japan hosted in Aichi prefecture. More than 22m visitors went to Aichi to imagine a world in which robots are part of everyday life and technology is the Earth's best friend. Along with the robots that Japan hopes will one day give directions, collect rubbish and babysit, are prototypes of robots that will be used in health care and search-and-rescue.

While visitors queued up to get a glimpse of Aichi's robots, they were surrounded by technologies designed to help the environment. As you might expect in an exposition dedicated to “nature's wisdom”, the latest solar cells powered parts of the site; the shuttle buses were equipped with fuel cells; and a power plant converted waste into energy. To beat the summer heat, the Aichi site also featured a range of new building materials and techniques that aim to keep down the temperature without energy-wasting air conditioners. These included walkways made of recycled materials; ultra-fine sprays of dry mist; and roofs coated with titanium-oxide, which lets water evaporate rapidly to lower the ambient temperature.

And yet, in spite of Aichi's extravagant display of new ideas, Japan and its companies no longer have a reputation as world-beating innovators. This, say the country's detractors, reflects an “outdated” way of doing things—a lack of creativity, flexibility and risk-taking. As a result, Japanese firms are no longer able to stay at the forefront of the most important and profitable new industries.

Japanese firms have not counted for much in software, the internet, biotechnology and other high-growth industries over the past decade. Japan can boast no equivalent of Microsoft, Google, Amazon or eBay. Its entire software industry has failed to make an impression on the world. Its best-known internet company, Softbank, is better at shuffling paper investments in subsidiaries than at inventing new technologies or business models. The new kid on the block, Takafumi Horie, head of livedoor, is most famous for three failures: a failed takeover bid for a baseball team, another for a broadcasting company, and an unsuccessful campaign for a seat in parliament. Although a handful of Japanese pharmaceutical firms have developed a few profitable drugs, Japanese companies are also far behind the rest in biotechnology and medical devices.

Japan's lack of success is not for want of trying. The country continues to lead the world in research and development, investing 3.2% of its GDP in R&D, compared with 2.6% in America and 2% in the European Union. Moreover, unlike western countries, where government and university labs generate lots of breakthroughs, Japan performs more of its R&D in big companies. An official at the once-mighty ministry of economy, trade and industry complains that METI's entire R&D budget is no bigger than that of Toyota. That is one reason why so many Japanese firms are near the top of the global tables for technology patents (see chart 1).

Instead, the country's failure has much to do with its method of management and organisation. This won extravagant praise in the 1980s, when western writers and businessmen flocked to Japan for answers, and when the “lean” production manufacturing techniques pioneered by the likes of Toyota changed the world. The Japanese way of running companies has since fallen out of fashion, however. And although Japanese managers are slowly getting a little younger and nimbler, partly in imitation of American norms, the leisurely pace of business reform seems no match for the rapid rate of change in cutting-edge industries. Japan also suffers from a stifling environment for technology start-ups and a rigidly bureaucratic university research system that is poorly connected to the private sector.

New ventures needed

These are daunting disadvantages—as plenty of Japanese businessmen, scientists and politicians acknowledge. Indeed, Japanese officials and business leaders have taken the first steps towards remedying some of them. A few Japanese bankers have set up funds to promote venture capital (or at least what passes for it in Japan). The government has also converted all of Japan's national universities into public corporations, in a bid to shake up scientists' civil-service mentality and make them more flexible and innovative. New clusters and consortia are popping up all over the Japanese islands, to promote better links between university laboratories, government budgets and corporate R&D. Between 2000 and 2003 the number of start-ups created to commercialise discoveries at Japanese universities rose from 315 to 800.

Although these efforts may eventually bear fruit, it will clearly take a while. Yet to focus on the slow pace of reform in Japan is to miss an important point: that there are many ways to innovate, and no single approach is “right” for all times and technologies. Japanese companies are already very good at—indeed, lead the world in—many types of innovation. The reason they lost their edge in the 1990s is not so much because their approach to innovation was “wrong”, as because it was ill-suited to the sectors dominating that decade. The next few years could easily be different, since the battle over next-generation technologies may well be in areas that suit the Japanese far better than biotech and software ever did.

In biotech and software America gained a clear edge from its ability to let lots of start-ups experiment with new techniques and business models, and to commercialise ideas from university research laboratories as quickly as possible. America's other advantage is in basic scientific research. Its universities dominate rankings of the best in the world and are well integrated with government and business laboratories. In other technology-heavy sectors, however, including several that Japanese companies are betting on, the university laboratory and the entrepreneur's garage have less of an advantage over a big Japanese corporation with extensive business experience and a giant R&D budget.

The American start-up method works very well when hundreds or thousands of potential business models might succeed—and the best way to find out which is to allow each brave or disgruntled genius to try out his own approach. Many fail, but a few succeed.

In other industries and technologies—such as cars and electronics in the 1970s and 1980s—a better way to innovate is to learn by doing. If 100 start-ups try, all might fail before they learn anything useful or before they come up with a product or service they can sell. A big company is often better suited to such fields. Not only can it offer its innovators a more reliable source of investment capital, but it also has links to consumers, which it can use quickly to improve the next generation of whatever it is making. A big company in a new field can afford to make products with initial drawbacks, provided it learns quickly to overcome them.

As they once did in cars and electronics, Japanese companies are today pursuing future technologies in several industries by making things first and only then pausing to think about how to improve them or put them to new uses. This leaves them at a familiar disadvantage in blue-sky research. But the idea—which has worked well enough in other industries to turn Japan into the world's second-biggest economy—is to keep getting better, eliminating costs and boosting quality, while rivals in America and Europe waste precious time at the drawing board. When Japanese companies do it right, they can innovate so quickly that they leave western competitors gasping for air.

Sunny side up

One example that has received little attention is solar cells. Critics of the technology argue that it is not cost-effective and therefore cannot make any headway against other power sources without huge government subsidies in a few countries (notably, Japan and Germany). The doubters conclude from this that solar energy is a pipe dream, hardly worth the effort. Japan's manufacturers turn this thinking on its head. Instead of waiting until the price is low enough to promise a market, they are relentlessly attacking the technology now, in an effort to drive down costs more quickly through trial, error and continuous innovation.

This is happening faster than most people realise. Prices of solar panels for residential use have been falling by 7% a year over the past decade, according to Cambridge Energy Research Associates (CERA), thanks largely to manufacturing improvements in Japan. CERA attributes most of the cost cuts to economies of scale and incremental improvements in efficiency, as Japanese manufacturers have designed ever-thinner components while continuously lowering their defect rates. This is exactly the sort of method that enabled Japan to gain an edge in other industries, from semiconductors to LCDs, and to hang on impressively against fierce competition from lower-wage countries.

This is no coincidence. The four biggest Japanese solar companies—Kyocera, Sharp, Sanyo and Mitsubishi Electric—are electronics firms and know from experience that these techniques work. These four firms now earn roughly $1 billion in combined revenues from their solar businesses and they are continuing to expand their capacity. CERA reckons that prices will keep falling rapidly, and that by the end of the decade solar energy may be able to compete with other forms of residential power—even without subsidies.

As with solar technology, many of Japan's biggest companies are investing heavily in a few high-tech fields that they hope will turn into huge new markets. Along with its continuing interest in cars and IT-related gadgets, corporate Japan is especially keen on three market segments: aerospace, robotics and technologies that either go easy on the environment or help to clean it up. The first of these markets, aerospace, is already big globally, but has mostly been dominated by American and European firms. The other two are small, but Japanese firms expect demand to grow sharply during the next few decades. Japanese researchers—like their rivals in America and Europe—are also investing heavily in nanotechnology, hoping that a mastery of all things tiny will help them make better integrated circuits and materials, which they can then use to transform a wide range of industries.

Man or machine?

Japan's biggest, and some of its most familiar, companies are leading this technology push. Some of the most eye-catching humanoid robots, for example, are being developed by car companies such as Honda, electronics firms such as Sony, and big technology groups such as Mitsubishi Heavy Industries. The same collection of carmakers, electronics companies and industrial firms are leading the charge into new environmental technologies, including fuel cells, solar cells, energy-saving building materials and methods for cleaning up water pollution. And as Japan advances into aerospace, its big electronics companies (such as NEC and Toshiba, which have formed a joint-venture, NT Space) and its industrial firms (Mitsubishi Heavy Industries, Fuji Heavy Industries and others) are at the forefront.

In aerospace, the Japanese have less experience than their American and European rivals, whose governments are also further ahead in blue-sky research. But they are trying. In October the Japan Aerospace Exploration Agency (JAXA) successfully tested a supersonic jet over the desert in South Australia. Japan's last attempt to make the thing fly, in 2002, ended in an explosion. Similar failures have plagued Japan's rocket programme, stalling the country's plans to launch commercial satellites. But none of this has deterred JAXA or Japan's industrial firms, which have aerospace ambitions ranging from commercial aviation to space exploration.

Along with Japan's mastery of electronics and integrated technologies, those companies are counting on advanced new materials to give them an edge in aerospace. Consider Toray Industries, Japan's biggest textile company. Many of its products—such as airbags for cars and colour filters for LCDs—are high-value items. So despite falling demand for its futon fillings, Toray's operating profits rose by more than 40% last year.

Since margins in today's best segments will eventually shrink, however, Toray is investing heavily in new ultra-light and flexible composite materials to replace, among other things, the aluminium tubes used in commercial aircraft. Instead of worrying about Chinese competition in T-shirts and trousers, as western textile firms do, Toray is helping to make Boeing's new 787 commercial jets.

Altogether, Japanese firms will provide 35% of the Boeing 787, making entire wing sections from ultra-light composites before they are shipped to Seattle for assembly. The main contributors, besides Toray, are Mitsubishi Heavy Industries, Fuji Heavy and Kawasaki Heavy. In Japanese fashion, they are hoping that huge investments and lots of practice will give them an edge.

They are not just practising with Boeing. More than 20 Japanese firms will be involved in building the A380, Airbus's new jumbo jet. With the experience it is gaining and the investments it is making, Mitsubishi Heavy Industries (which made the “Zero” fighters Japan flew in the second world war) plans eventually to start building its own mid-sized commercial jets. That segment is dominated by Canada's Bombardier and Brazil's Embraer. Mitsubishi is also among those co-operating with America on missile defence; and it is leading Japan's (so far unsuccessful) drive to put commercial satellites in space.

Japan's high-tech companies are pursuing a similar approach to other technologies. Toyota, which views battery-and-petrol-driven hybrid vehicles as a stepping stone to even more fuel-efficient cars, has already begun testing fuel-cell vehicles in America. It will keep working to perfect the technology, even as American rivals such as GM and Ford struggle to compete with Toyota's hybrid models.

Japanese manufacturers such as Honda, Sony and Mitsubishi Heavy Industries are hoping that robots will succumb to the same approach to innovation that they have used on cars, electronics and industrial equipment. Although other rich countries are also doing research in robotics, Japan is far ahead in developing robots with humanoid features. Japanese companies are betting that, as these get smarter at walking, talking, dancing and being useful they will become the coolest and priciest toys in many homes. When it walks up to you, studies your face and greets you, Sony's humanoid prototype, QRIO, bears little resemblance to the firm's other consumer-electronics gadgets. The only hint of its true lineage is its one-hour battery life. But QRIO is an integrated device and Sony will keep tinkering with it and improving it in the same way that it once did with the CD player and the Walkman.

Look to America

In all of these areas, Japan's advantages should help its companies to avoid the problems that beset them in the 1990s. Nevertheless, the country can still learn from America, where researchers pay close attention to the market and are rewarded for success, and in which small firms are always popping up with bright new ideas. Some Japanese technology managers are trying to learn from this, as well they should. With an ageing population that will begin shrinking by 2007, Japan has also failed to tap a ready source of potential new researchers. Just over 10% of Japanese researchers are women, compared with one-third in America and more than a quarter in Britain, France and Italy.

There is no guarantee that consumers will demand the sorts of products that Japanese companies plan to make. Robots are an obvious gamble. While Japanese researchers struggle to make them ever more life-like, some clever American company (Dell Robots, perhaps?) may find a cheap way to sell simple and functional robotic devices that consumers are more likely to want—outside Japan, at least.

For all the challenges they face, however, the future for Japan's big companies is not as grim as the 1990s made it seem. China has mastered the T-shirt and America dominates the internet. Japan has the technology to put up a good fight over much of what lies between.